How to Invest ‘Subject To’ and Overcome the “Due on Sale” Clause

Since opening up the EpicProAcademy, the majority of questions have revolved around “how to invest ‘subject to,” and specifically how to overcome the “due on sale” clause. Investing ‘subject to’ is when a motivated seller signs over the deed to you while you continue to make payments on their existing financing. You have taken ownership of the property subject to the existing financing. You, the buyer, own the property while the seller still owns the liability of the loan.

How to invest ‘subject to’ is actually a very simple strategy, but like every strategy it’s not going to be a good fit for every situation. Whether it’s seller financing, lease options, private money, hard money, whatever it may be… ‘subject’ to is just another tool in the toolbox of which enables you to use someone else’s money to transact your real esate. Typically, your ideal situation for ‘subject to’ investing is just about any situation where a quick takeover of the property is in order to solve the challenge at hand.

Ok, so why would a seller agree to such an arrangement? Remember, at the center of every real deal is the seller’s motivation to sell. First, you do need a motivated seller for this strategy to be applicable. When you do find the right situation and takeover a motivated seller’s payments, the seller benefits by getting peace of mind and preservation of their credit score. Should the seller raise a concern around whether you’ll follow through and actually make the payments, you can explain that the risk of losing your money in the deal and the equity in the property is enough to keep you from missing payments. The answer to the question “how to invest ‘subject to” is not a complicated one. As long as you are clear with regard to what “subject to” is, it’s not as difficult to execute as it may seem. If you know how to explain it to the seller, and what steps to take to protect you and the seller, you can use the ‘subject to’ strategy over and over with minimal risk.

As great as this strategy can be in your real estate investing, however, there are some things of which to be aware. There are precautions you should take to protect both you and the seller.

First, make sure that the seller knows everything that you know about how to invest ‘subject to.’ Full disclosure with the seller will keep you out of a lot of potential trouble. The last thing you want is to find yourself in court with the seller accusing you of stealing their home. The investor almost never wins this argument unless you’ve covered EVERY base, and even then there could be some risk. Just be straight with people, make sure everyone involved gets what they were promised and you should be okay.

Second, don’t take over a property just because the owner agreed to give it to you. It can be very exciting, especially if it’s the first time for you, when a seller signs over the deed to you. Nonetheless, it still has to be a good deal. It still must be a property that meets your criteria and moves you toward your goals meeting your minimum deal standards.

Third, and this is the biggest one! It’s one of the most feared and misunderstood, yet most fascinating, subjects in real estate investing. The dreaded “due on sale” clause. As simple as a subject to transaction can be, it’s this specific clause found in most loan documents today that stops most investors dead in their tracks from moving forward on a ‘subject to’ deal. It’s the primary reason people are searching for answers of “how to invest ‘subject to.” Once you understand the “due on sale” clause’s history, purpose and how to work with it, you’ll find that there’s really nothing to fear but fear itself.

The “due on sale” clause, also referred to as an “acceleration” clause, is an authority clause in a loan document that gives the lender the right to call the loan due. Many people think the “due on sale” clause applies only when title of the property is transferred away from the borrower’s name, not true. Most “due on sale” clauses paint with a very broad stroke and just about any modification to title, interest or possession can trigger the clause. Even with this broad spectrum of rights, lenders rarely exercise this right because it’s typically not in their best interest to do so.

Then if it’s not in their best interest, why is the clause there?

Lenders began including “due on sale” clauses in their loans back in the ’70‘s during a time where interest rates rapidly increasing. Instead of taking out new loans… regular Tom, Dick and Mary “home buyer” were assuming the existing loans on homes because the interest rates of those loans were so much lower than new loans.

Lenders then started to insert the “due on sale” clause to protect themselves from themselves citing that they needed this clause to protect their collateral by staying abreast of who was actually living in the properties. B.S.! Lenders only wanted to generate new loans at the higher market interest rates. As time passes, the lender’s actions (or lack thereof) prove this to be so. Lenders haven’t regularly enforced “due on sale” clauses since the early ’80’s. Why? Because interest rates have been on a fairly steady decline since then and they’d lose money if they wrote new loans at the lower rates.

By the way, you’re not going to jail for violating the “due on sale” clause. Did you hear that Realtors??? It’s not illegal. In order for something to be “illegal,” there must be a violation of an actual law. There is no federal or state law stating it’s a crime to violate the “due on sale” clause. The worst thing that could happen to you is that the lender exercises their rights under the due-on-sale clause and takes the property back, and even then… they can’t do it inside of 30 days (hint!, hint! for the wholesalers reading this), and even after the 30 days if the property is occupied, the lender will have to abide by normal foreclosure proceedings of which should be enough time for most fix and flippers to execute their strategy (hint! hint! for the fix and flippers reading this).

So, what about the long term investors? Are you willing to takeover a property ‘subject to’ with the risk of the lender busting you? If you’re willing to take the “risk,” you have two real viable options on how to approach it. You can either sneak in the back door, or you can go in the front door screamin‘ “Honey, I’m home!”

You see, there’s a loophole that many investors like to exploit. The Reagan Administration back in 1982 enacted the Garn-St. Germain Depository Institutions Act of which was intended to revitalize the housing industry by ensuring the availability of home loans. Within the act there was a significant consumer benefit included that allowed anyone to place real estate in their own trust without triggering the “due on sale” clause. Primarily for estate planning reasons, real estate investors recognized an ancillary opportunity using a land trust.

A land trust is an agreement of which one party (the trustee) holds ownership of a piece of real estate (real property) for the benefit of another party (the beneficiary). The real estate investor opportunity being that the transfer of real estate using a land trust is EXEMPT per the Garn-St. Germain Act. Get it? I’ll break it down to you in three simple steps.

So, imagine you come across a great deal. You have successfully found a property that meets your criteria and a seller that will meet your terms; And your terms being you want the property subject to the existing financing. Good to go!

STEP 1: Your motivated seller signs a land trust naming you as the trustee. The seller is the beneficiary. Following me?

STEP 2: Your motivated seller transfers title to YOU, the trustee (Thank you Garn-St Germain Act). As per this action, there is no violation of the “due on sale” clause. The transfer to a trust is exempt. Excited yet?!

STEP 3: The motivated seller now assigns their interest in the trust to you. This assignment isn’t recorded, meaning that there’s no public record of it. The motivated seller then moves out and goes on about their business, and YOU or your tenant move in! Ta dah!

You are now the beneficiary of the trust, the beneficiary of the trust that owns the property. Now, the trustee (also you) makes the existing loan payments and you live happily ever after, right?! Well, it’s not that cut and dry. You MUST know that when the motivated seller assigned to you their interest in the trust that that indeed triggered the “due on sale” clause, but who’s going to tell the lender?

Typically, there are only three real ways of which the lender will get wise to the transfer. I explain those three ways in this video.

So, that’s how to invest ‘subject to’ sneaking in the back door. Let’s try the front door now.

Imagine the same scenario with our motivated seller in our previous example. As soon as you get an agreement from the seller allowing you to takeover the property subject to the existing financing, turn the entire file over to a third party servicing company and let them do the rest. Let them do everything. Let them communicate with the seller. Let them communicate with the lender. Completely remove yourself from all parts of that conversation. And here’s why…

It’s similar to how when attorneys talk to other attorneys. They speak the same language. They respect each other’s position. They just pass paperwork back and forth like it’s an every day thing… because it is. And when note servicing companies are speaking to other note servicing companies, it’s just like that. It’s just passing paperwork back and forth.

Once the note servicing companies have completed their duties, all there is to do is make the payments. Actually, in both scenarios you want to make the payments. Do NOT miss a payment. You put in all that work, got a smokin‘ deal, and you stand to make a great profit. Don’t mess it up by missing or being late with a payment. Don’t give the lender any reason to call you. That’s one of your strongest lines of defense against the “due on sale” clause, and here’s why…

In today’s market with the amount of foreclosures, pre-foreclosures, short sales and loan mods, do you think the lender would have the man power or even the interest to police their accounts that are in good standing??? No way!

Okay, so that’s how to invest ‘subject to.’ All fine and dandy, right? But what about ethics?

Glad you asked.

If it were unethical or fraudulent, then why would so many different states in their standard state Realtor Association purchase agreements and paperwork include ‘subject to’ as a financing option on the contract? CA has it, Utah has it, and New York has it to name a few.

Further, the state bar associations of Alaska, Illinois, and Virginia (among other states) in case after case have had no problem with lawyers aiding their clients in concealing these types of property transfers using the land trust example I just gave you.

So, if it is not illegal, unethical or fraudulent for an attorney or broker to sneak in the back door… it isn’t for you, either.

The most you’ve got to lose is the time you’ve invested and the money you put in the deal, of which brings me to best practices when investing subject to.

It’s an ideal strategy for short term investing such as wholesaling and fixing and flipping. Go for it! Now, if your subject to investment is going to be a long term hold type play, I would recommend not investing any more in the deal than you’re willing to lose. And here’s why…

If you give a motivated seller $50,000 down to takeover his property subject to the existing financing and two years down the road the interest rates make a big jump up, it’s very possible that lenders might start investigating their lower interest loans. It’s not likely, but it is possible. And in the event that they do, they could accelerate the loan and take the property back of which you’d have to say goodbye to your $50,000.

So, if it’s a short term strategy, go for it! If it’s a long-term strategy, just be careful of how much you put in the deal upfront.

Hopefully, I’ve been able to clear the air a bit and dispel some myths around how to invest ‘subject to’ and overcome the “due on sale” clause. It’s an awesome strategy to have in your tool belt, but it does you no good unless you actually use it. I’m assuming you are now armed with enough information about ‘subject to’ and the “due on sale” clause that you can make an educated decision for yourself whether this is a strategy for you, or not.

If I’ve left you with some questions, share them with me in the comment section below. Also, if you found this information valuable… please do me a favor and click the FB “like” button below or lend me a tweet 🙂

Although many investors successfully invest long-term using “subject-to,” I typically won’t enter a subject-to deal with long-term intentions if I have to put any significant money into the deal. I’m not so concerned about the equity long-term as I am losing the money that I’ve put into the deal.

To answer your question specifically, do you “need” to be concerned about your equity? You should always be concerned about your equity in every deal 🙂